May 11, 2020 / 7:53 PM / By Coronation Research / Header Image Credit: Ecographics
It is the role of equity markets everywhere to predict company earnings and future economic conditions. Generally, equity markets rally far ahead of the end of recessions. The current rally in the Nigerian Stock Exchange All-Share Index, which is up 16.3% since 6 April, is therefore intriguing. Does it predict the resolution of Nigeria's problems, as the rally from April to December 2017 did? And, if one is unsure about that, how should one position an equity portfolio?
Last week we wrote that the International Monetary Fund's (IMF) recently-approved Rapid Financing Instrument (RFI) facility of US$3.4 billion (N1.3 trillion) for the Federal Government of Nigeria (FGN) could boost the Central Bank of Nigeria's (CBN) external reserves. The CBN's reserves grew by US$449.3 million during the week to US$34.2bn, though this was helped by an apparent inflow of money recovered from the estate of a former military ruler. Either way, this is the first reserve accretion since the start of the year. Against this backdrop, the Naira appreciated against the US dollar by 0.01% to N387.25/US$1 in the main interbank FX market, the NAFEX market, and by 4.12% to N437.00/US$1 in the parallel market. While this is positive, it is not the case that that FX turnover overall is recovering or that private-sector capital inflows have resumed. This just lifts the immediate pressure on the exchange rate, in our view.
Bonds & T-bills
The secondary market yield for a Federal Government of Nigeria (FGN) Naira bond with 10 years to maturity declined by 35bps to 10.94%, and at 3 years contracted by 2bps to 8.29% last week. The annualised yield on 279-day T-bill, remained flat at 3.19%, while a CBN Open Market Operation (OMO) bill with similar tenure closed at 11.89%, 249bps down week-on-week. We think T-bill rates will rise over the coming month though high liquidity, such as last weeks N96.9bn (US$230.8m) of OMO maturities, is likely to keep such rate rises modest.
The price of Brent rose by 17.13% last week to US$30.97/bbl. The average price, year-todate, is US$43.81/bbl, 31.75% lower than the average of US$64.20/bbl in 2019, and 38.89% lower than the average of US$71.69/bbl in 2018. The key driver in the recent rise has been the clearing of global inventories that weighed on the market in April. The market now contends with global oil consumption variously estimated at 30%-35% below its peak and production variously estimated at 10%-15% below its peak. This suggests that the market is taking its time to move back into balance, though eventually it must. The result, in our view, will be slow appreciation of Brent prices as we approach the third quarter of the year.
The Nigerian Stock Exchange All-Share Index (NSE-ASI) advanced by 4.45% last week. The year-to-date return is negative 10.42%. Last week Ardova Oil (+32.47%), Nigerian Breweries (+25.00%), Dangote Cement (+15.38%), Nestle Nigeria (+8.67%) and Zenith Bank (+7.69%) closed positive, while Lafarge Africa (-6.78%), Access Bank (-3.03%), Guinness Nigeria (-2.17%) and Sterling Bank (-1.56%) fell. Sectoral performances this week were positive. The Consumer Goods sub-index (+8.5%) led the gains, followed by the Banking (+4.0%), Oil & Gas (+2.8%), Insurance (+2.8%), and Industrial Goods (+2.2%).
An equity market rally. Is it predicting the end of austerity?
Is this the equity market rally that takes us all the way from April through to the end of the year? The question comes up because the equity market is rallying (it is up 16.3% from its low point on 6 April) and because there appears to be a parallel with the equity market rally from April to December 2017, in which the Nigerian Stock Exchange All-Share Index (NSE ASI) returned 51.8% in Naira (and 32.6% in US dollars at the interbank rate). Nobody wants to miss a rally like that.
It is the task of equity markets to predict future economic conditions and future company earnings. So this might be the rally that heralds a recovery later this year, as in 2017. However, the 2017 rally began nine months after a serious exchange rate dislocation (in June 2016) and after five quarters of negative economic growth. A consensus was being reached, as the NAFEX foreign exchange market was launched in April 2017, as to where Naira/US dollar would settle in the interbank market. Today the recession still appears to be both current and be ahead of us, and currency fluctuations (e.g. in the parallel market rate) are still quite recent. On balance, it feels that we are still close to the beginning of troubles in the market, and that it is too soon to see the resolution of these issues. In April 2016 there was a rally (through to July) but it fizzled out later in the year.
So, do we take fill our notional Model Equity Portfolio with equity, or remain cautious? We do not like to make binary choices, still less successive binary choices, about the direction of the market. As Oatree's Howard Marks put it: "The bottom" is the day before the recovery begins. Thus it's absolutely impossible to know when the bottom has been reached... ever." He recommends spending some money when equity prices are low in the stocks you would like to own, but to be prepared to accept further corrections if necessary.
We think this is a wise approach - buy good stocks when they are at historically low levels, but don't overdo it. Over the past few weeks have raised our notional positions in MTN Nigeria and Dangote Cement, while enjoying strong performance in our selection of the major bank stocks. This has given us some performance without having to take the binary choice of betting on a market rebound. And our key strength is having a small notional Model Equity Portfolio and having flexibility as to how much equity and how much cash we hold. Very few professional equity portfolio managers have this luxury. Our selections express our thoughts on the market and how to survive it without having to call the bottom.
Previous Nigeria Weekly Update - Coronation Research